Eaton Vance: New ETFs will challenge passive players

Branded as NextShares, the funds – the first of which were launched in the US in February – enable an active fund to exist inside an ETF without having adhere to the daily transparency required of traditional ETFs, meaning managers avoid giving away their investment IP.

In July, Eaton Vance announced it had struck an agreement with UBS Wealth Management to distribute the funds through its financial adviser network.

There are now seven NextShares funds trading in the marketplace, three run by Eaton Vance and four which the firm has licensed out to other fund managers. Eddie Perkin, equities investment chief at Eaton Vance, tells FN about his hopes for the vehicles.

What is the latest with Eaton Vance’s NextShares push?
We’ve spent the last two years trying to develop this into a commercial business, we’ve signed up over a dozen mutual fund companies to license the technology from us so they can launch their own strategies in the NextShares structure and we’ve also signed up a couple of broker dealers, such as Folio Investing, which is a small broker dealer.

The big one is UBS – it has signed up to distribute and make available to their clients and their brokerage and advisory businesses the NextShares vehicles, that’ll happen next year.

And so everything is coming together. It is kind of a chicken and the egg problem where you need enough of the mutual fund companies to adopt this to make it of interest to the broker dealers and vice versa. Now we feel we’ve cracked that chicken or the egg problem so we’re quite optimistic about 2017 for NextShares.

What are the benefits of this structure for investors compared to traditional active funds?
The benefits for the clients are there are four or five frictional costs that exist in a mutual fund that do not exist in the ETF structure – things like sub-transfer agent fees or cash drag, because in a mutual fund you have to meet redemptions and so you carry cash to meet redemptions. Whereas in an ETF you redeem in kind so you don’t have to carry cash, you don’t have a performance drag from cash and so I think it is objectively a better structure than a mutual fund.

The mutual fund industry in the US is over $ 10 trillion in size but the sort of dream scenario for Eaton Vance and the industry is over time we move mutual fund assets into this structure, we collect a small fee on a multi trillion-dollar asset base which would be significant, the client gets a better experience because performance is better and active managers win the day against passive, because with the benefit of this structure the performance track record looks a lot better than it otherwise would.

Do you envisage a day when all your actively-managed funds are invested in the NextShares structures rather than mutual?
Yeah conceptually, several years in the future that would be the hope. I think we’re a long way off but there’s no reason why that can’t happen eventually.

Are any other fund managers as far down the line as you?
There is no-one else that has got [SEC] approval, no-one else wants to put an active strategy into a traditional ETF so we’re kind of the only game in town.

How have you circumvented the requirement for ETFs to disclose their holdings on a daily basis?
In a traditional ETF the basket of securities is just what is held, [for example] the S&P 500 ETF. For an active ETF I’d have to publish a basket, [but] I don’t want to disclose my full portfolio. I might be in the process of building a position so I can create a basket that looks similar to my fund but not identical but I have to stand ready to redeem that basket or receive those securities, so if it’s too out of proportion with my existing fund I might end up with my fund misshaped. Every day I have to publish a basket, but I don’t have to publish my holdings strictly as they are.

So it is a more rough outline so as not to give the game completely away?
That’s right and in particular if there are less liquid securities, where I’m in the process of increasing or decreasing the position, I’d be careful not to tip that off.

To what extent could this development be a game changer for active managers?
It is our hope as a firm that that will happen, that this is unquestionably, objectively a better structure, a better deal for the end investor. For intermediaries it is good too because the asset management firm does not need to lower their fee – all the frictional costs I talked about doesn’t come out of the wallet. It is a good deal for the client, it is a good deal for Eaton Vance, and the asset management firm. It’s a way for them to compete more effectively with passive and to offer their best active strategies in an ETF structure which has some advantages over a mutual fund.

How big are the funds?
Tiny, it is just seed capital at this point. The only place you can really buy them right now is through Folio Investing which is a small broker dealer in the US.

To what extent do you hope that the deal with UBS will give these products real traction?
UBS is committed to not only carrying this on its platform but training – they’ve got hundreds of financial advisers and are training them on ‘what is this product, how does it work, how would your clients get into it?’ Marketing materials, training sessions, all those things. UBS is so far proving to be a very good partner and they’re treating it as a strategic initiative of their own and we’re hopeful they can convince other fund management companies to adopt it as well.

What we really want is other fund companies to sign a licensing agreement with us where they pay us a few basis points and we’ll give them the technology, the training and the tools to have a NextShares fund of their own.

So effectively taking the NextShares vehicle and running it themselves, almost wholesaling the vehicle? Yes exactly. So UBS will distribute NextShares funds from whichever fund company wants to put them into the marketplace but in order to be able to put them into the market place they need to come to us and sign a licensing agreement.

How many firms at the moment are in the market for coming on board?
We’ve announced about a dozen [including Columbia Threadneedle Investments and Pioneer Investments] and we’re constantly talking go others. We expect to announce more next year.

How many funds you want to launch next year?
So we’ve done three and we’ll likely do more next year once UBS is up and running. For now, the main point of launching the first three was to prove these things trade well, which they did. They trade at a very tight bid-offer spread, they exist, they’re up and running, they’re available, the concept is proven and before we launch too many more we need to have wider distribution.

Would you consider bringing this vehicle over to Europe?
It is such a huge opportunity in the US. In some ways I think the product is more suited to the US market because of the way mutual funds work in the US – there is a tax benefit [in the US], so that particular element of this would not be to the benefit of European clients. The US market is so huge that we really honestly haven’t discussed it yet, but if there is interest down the line I’m sure we would be interested to pursue that.

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